US leaves Iran nuclear deal

09 May 2018

Analysis

Global

Creating a Secure Organisation

Resolving Critical Issues and Crises

The US withdraws from the Iran nuclear deal (JCPOA)

Key takeaways

The US action was maximal and more severe than expected. President Trump could have re-imposed some sanctions, but remained in the deal to continue negotiations with Europe and the US Congress. Instead, he chose to withdraw entirely, ending negotiations, and re-impose all sanctions. Trump suggested that the objective of the policy was to force Iran back to negotiate a ‘new and lasting deal’.

Sanctions risks will increase, but not to pre-JCPOA levels. US sanctions are significant and extraterritorial, but also unilateral. Unlike pre-JCPOA, there is not a united global sanctions regime: the UN, EU and other countries will not re-impose sanctions, and may instead take action to shield their companies from any US sanctions. Russia and China will largely continue business as usual with Iran.

The US action is very damaging to relations with Europe. Not only did Trump ignore the last-minute, personal appeals from French President Emmanuel Macron and German Chancellor Angela Merkel, he rejected months of negotiations with France, Germany, and the UK that had resulted in material European concessions. Europe, which remains in the deal, will view US withdrawal as a threat to regional and global security, as well as a sanctions risk for European companies.

The action will drive up global oil prices and potentially harm the global economy. By early 2019, financial sanctions targeting Iran’s oil exports could cut global production by up to 1m (depending on Asian countries’ compliance with US sanctions), adding to strong demand and OPEC cuts. Higher oil prices will benefit the energy sector, and oil exporters, but hit consumers and manufacturers with higher inflation.

Regional conflict risks are contained, but could increase if Iran resumes large-scale enrichment. Iran has indicated that it will remain in the deal, at least initially, to sustain its diplomatic and economic benefits. However, since the US broke the deal, Iran could choose to resume enrichment or limit the inspection regime, which would be likely to trigger renewed threats of military intervention by the US and Israel. The most likely location for an immediate escalation is southern Syrian and northern Israel.

Geopolitical stability has been undermined

The US decision undermines geopolitical stability and further isolates the US. The basic Iran nuclear ‘deal’ of giving up uranium enrichment in exchange for sanctions relief is effectively dead, as all credible observers agree that Iran has complied with the terms of the JCPOA.

Iran is trying to win international credit by announcing that it will stay in the JCPOA at least for the next several weeks. In this way, Iran aims to re-establish itself as a trustworthy actor that will keep its commitments. In addition, President Hassan Rowhani has asked the other signatories to protect Iran's interests. The aim is to widen the split between the US and its European allies and enlist the latter to cushion the effects of the impending return of the US sanctions. Iran's reaction shows that the Islamic Republic has nothing gain from an imminent withdrawal from the JCPOA.

Trump hinted that the withdrawal was linked to impending direct talks with North Korea on its nuclear programme. He stated that Secretary of State Mike Pompeo was en route to Pyongyang to advance planning for the talks, which he previously said could occur by late May. It is unclear what lesson North Korea might draw from JCPOA withdrawal, but its situation as a de facto nuclear state is already substantially different.

US relations with Europe suffer a blow

The US decision is a major blow to relations with Europe. The JCPOA is a signature foreign policy achievement of the EU as an institution, which is both a signatory and guarantor of the deal. European countries consider the JCPOA, by constraining Iran’s nuclear programme, to be a pillar of national security and global stability. Europe made significant concessions to accommodate Trump’s unilateral demands and self-imposed deadlines, and the decision to withdraw from the deal anyway is a major affront. The EU has called for remaining parties to uphold the deal.

US-EU relations have also recently deteriorated over US tariff threats. The US on 1 May extended until 1 June a temporary exemption for the EU from steel and aluminium tariffs; the EU has threatened to retaliate against politically-sensitive US industries unless granted an ‘unconditional and permanent’ exemption. Trump has also threatened tariffs against Germany’s automotive industry, and criticised European monetary policy.

Russia wins, China loses and the Middle East is divided

Conversely, the US decision is a geopolitical win for Russia, which benefits from further discord in the Western alliance and from higher global oil prices. Russia will continue to implement the JCPOA and keep its business ties with Iran.

The US decision is a net negative for China, which must face higher oil prices (as the world’s largest oil importer) and increased sanctions risk (as a major consumer of Iranian crude). (The US after 2012 granted China a series of waivers from oil sanctions, as the JCPOA was being negotiated). China will continue to implement the JCPOA and keep its business ties with Iran, but may reduce oil imports.

While Saudi Arabia may applaud the harder US line against Iran, and view Trump’s action as support for a policy of regional containment, the threat to the integrity of the JCPOA will raise concerns about a regional conventional and nuclear arms race. Saudi Arabia has said that it will seek to maintain parity with Iran in terms of enrichment capability or access to nuclear weapons.

Israel’s administration has applauded the decision. Prime Minister Benyamin Netanyahu’s administration has been one of the few opponents of the deal since it was signed. Israeli statements have echoed Trump’s criticisms. Israeli military and intelligence sources are quoted as saying that Iran might be considering a response. Israel has opened public shelters near its northern border and deployed its Iron Dome missile defence system.

Iran does not have much to gain from launching military strikes against Israel while it tries to sustain the deal with Europe, China and Russia. However, there are two other plausible escalatory steps. Iranian allies in Syria could launch missiles or drones over the border. Israeli could use the charged atmosphere to launch strikes on Iranian assets and allies in Syria.

Sanctions: the snap-back

The changes announced by the US will see US primary and secondary sanctions return to their pre-JCPOA state by 4 November. Primary US sanctions apply to US persons and secondary US sanctions apply to non-US persons. The changes to US primary and secondary sanctions will be implemented in two phases: by 6 August and 4 November. We have no reason to doubt the US administration’s intent to enforce these sanctions at this point in time. However, the 6 August and 4 November deadlines to allow a window of time for additional negotiations with other JCPOA signatories to secure a new deal or for these signatories to announce measures to protect companies from their countries.

The first phase of sanctions (implemented by 6 August) includes restrictions on gold and metals, the automotive sector, and civilian aircraft sales.

The second phase of sanctions (implemented by 4 November) is much wider-ranging. It targets trade and investment in the upstream oil and gas sector, petrochemicals, and ports and shipping, and insurance. It also restricts interactions with Iran’s central bank and pressures third countries to reduce imports of Iranian oil and gas. General License H, which allowed foreign subsidiaries of US companies to do business with Iran, will also be removed.

Iranian entities that were de-listed as part of the nuclear deal will also be re-listed by 4 November. This means that US persons and non-US persons that engage with them will be exposed to US enforcement action. The Iranian entities that will be relisted represent a fairly exhaustive list of economically relevant institutions in the country.

Sanctions implications for business

The changes will mean that US and non-US companies unable to do business with Iran due to US primary and secondary sanctions prior to the JCPOA’s implementation in January 2016 will see their legal positions in the US return to that position.

The US government has advised companies in this position to end business activities that are not compliant with sanctions by 6 August and 4 November (i.e. 90 and 180 day wind-down periods from 8 May). The guidance indicates that companies should attempt to settle outstanding financial payments before these dates provided that the contracts were entered into before 8 May though the guidance suggests some flexibility to allow non-US companies to settle payments after the wind-down dates. Contracts entered into after 8 May will not be treated the same way.

Non-US companies can wait to see the response of their home governments to Trump’s decision. The other signatories to the JCPOA have stated their intent to maintain it, with European governments indicating their willingness to try to find a solution or additional deal. Trump has threatened to enforce US sanctions on companies from third countries and the changes to sanctions will provide a legal basis for US agencies to do that.

However, if other JCPOA signatories are unable to find a solution to placate the US administration and therefore stall sanctions being reinstalled then it is likely that the other signatories will attempt to find measures to protect non-US companies from US sanctions.